We Can Save Social Programs

Neil Brooks


The economy is in crisis. The need to cut government spending is urgent. Everyone must be prepared to sacrifice for the good of the country.

As Ottawa prepared its annual budget, this was the central message in the pre–budget presentations of business–sponsored groups such as the Business Council on National Issues and the C.D. Howe Institute.

As a cure for Canada’s economic ills, they peddle the standard business line that Canada no longer afford its social programs. However, it’s not necessary to soak the poor or dismantle Canada’s few remaining national institutions to reduce the deficit.

The most wasteful government spending programs are contained in the federal income tax act. It is presumably no coincidence that business groups seldom refer to these when they urge more government cost cutting since these subsidies benefit businesss and their owners almost exclusively.

Even a partial list reveals how the government could save more than $7–8 billion a year by cutting back on these cost–inefficient programs. Moreover, doing so would likely increase Canada’s international competitiveness since almost all these subsidies result in what economists call a misallocation of resources:

Repeal the subsidies for taxpayers who realize capital gains. The most inequitable and inefficient subsidies in the Income Tax Act are those that provide preferential tax treatment to taxpayers who realize capital gains. Taxpayers can realize $100,000 of capital gains tax free over their lifetimes, and now only 75% of gains more than this amount have to be included in their income for tax purposes.

From 1985 to 1988, $15.7 billion of capital gains were exempt from tax because of the lifetime exemption. The costs to the federal and provincial government was on average almost $2 billion a year.

Also, for each of these years, taxpayers reported another approximately $6 billion of capital gains. Only 50% of these gains had to be included in the income of taxpayers. Thus governments lost at least another one billion a year because of this subsidy.

Well over 50% of these subsidies go to the richest 1% of tax filers.

The government claimed that a subsidy for gains would spur venture capital activity. Venture capital represents a minute fraction of the assets that would typically qualify for capital gains treatment less than 1%, according to the U.S. study. Thus this subsidy to encourage risk–taking is not only viciously regressive but also it is absurdly inefficient.

Repeal the subsidy for those who invest in Canadian equity securities. Shareholders who receive dividends can claim a dividend tax credit. This reduces their income tax payable on dividend income by one–third. In 1988, this subsidy for shareholders cost Canadian governments about $750 million. One–fifth of one per cent of tax filers, those earning more than $250,000 received more than 20% of this subsidy.
The government introduced the dividend tax credit to reduce the cost of equity capital for Canadian firms. But in a small economy such as Canada’s, in which foreigners can freely invest and in which many large investors such as pension funds are tax exempt, attempting to increase share prices by giving a tax break to individual Canadian investor is futile. If share prices do increase because of the dividend tax–credit, foreign shareholders and tax exempt institutions are likely to withdraw some funds from this market. The over–all effect on the price of Canadian equity securities might well be negative.

Repeal the subsidy for corporations that make profits from manufacturing and processing. A 5% federal tax credit reduces the effective federal tax rate for firms that make manufacturing and processing profits from 28 to 23%. This tax subsidy was introduced in the early 1970’s to counteract a tax subsidy that the United State provided for American exporters. The U.S. subsidy was repealed in 1986.
After 1986, the government justified retention of this subsidy on the ground that Canadian manufacturing firms had to pay the manufacture’s sale tax. Since the government has now successfully replaced the manufacture’s sale tax with the Goods and Services Tax (GST), this tax credit should be repealed. The subsidy costs more than $1 billion a year.

Repeal tax subsidies for the real estate developers. Some of Canada’s largest corporations and wealthiest families are real estate developers. This is not an accident it is because, in part, they have received billions of dollars of government handouts through the tax system.

Real estate developers can write off the cost of the buildings they build or purchase, even though these buildings will likely appreciate in value. If the buildings themselves do not appreciate in value, invariably any reduction in the value of the building will be more than offset by an increase in the value of the underlying land. Also, developers can borrow money to purchase additional assets and secure the loan against the appreciated value of their older buildings, even though they have never paid tax on this appreciated value.

Repeal the subsidy for business meals and entertainment. Business people, including self–employed professionals, can deduct 80% of the cost of their “business” meals and entertainment. Yet the personal benefit from meals and entertainment are likely the same whether they are incurred in a business context or not. When almost 400,000 Canadians, including 150,000 children, are dependent on food banks for survival, this $1 billion subsidy for business meals and entertainments represents an outrageous perversion of collective morality.

In addition, like all these tax subsidies, this subsidy is not only inequitable, it creates economic inefficiencies. If the subsidies were repealed, Canada might have fewer workers waiting on and entertaining business people. But, since business would presumably continue to spend its gross revenues on activities designed to increase its profits, more workers would likely be engaged in other activities maybe even doing research and development!

Repeal the subsidy for business lobbying and other political activities undertaken by business. Business spends hundreds of millions of dollars every year lobbying governments for special treatment. A special rule inserted in the Tax Act in the early 1960’s allows these expenses to be deducted. The result of this tax rule is that the public is forced to subsidize the efforts of businesses to influence the political process, but not groups representing other points of view.

Repeal the subsidies for Canadian multinationals investing overseas. Canadian multinationals receive billions of dollars of subsidies under the tax laws, often to the detriment of the Canadian economy. Many of these subsidies have the effect of encouraging them to locate their manufacturing operations overseas. Thus, Canadians lose jobs, plant closings devastate communities, and Canadian interests are undermined.

For example, multinationals that borrow money in Canada to finance overseas operations can deduct the interest expense from their profits earned in Canada, even though the income the borrowed money earns in the overseas operation will never be taxed here. Billions of dollars have been borrowed from Canadian financial institutions for this reason. Thus not only does the subsidy encourage foreign investment by Canadian corporations and increase Canada’s current account deficit, but it also keeps Canadians interest rates needlessly high.

It is not only bad public policy, it is immoral for the federal government to cut back on social programs which benefit poor and middle–class Canadians in order to solve the deficit problem, while at the same time ignoring the inequitable and inefficient spending programs delivered through the tax system, which benefit the rich.

This article appeared in The Connexion Digest #54, February 1992.

Neil Brooks in Pro–Canada Dossier, now renamed Action Canada Dossier. Action Canada Dossier is available for $25 per year from Action Canada Network, 251 Laurier Avenue West, Suite 904, Ottawa, Ontario K1P 5J6.

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